The Dirty Dozen: 12 Genuinely Awful Investments

We know, of course, that many things, including security returns are not normally distributed, but for purposes of today’s topic, let’s not get picky and just focus on the green and red, and the idea that there are plenty possible outcomes on each side of neutral.

We hate the red portion of the diagram and should be trying to do everything we possibly can to try to set up situations in which the positive probabilities (the green) are larger than the negative (the red). But even if we can’t accomplish that (and in real life, this is easier said than done), we want to at least borrow from the medical community’s Hippocratic oath and “do no harm;” i.e. we need to bend over backwards to make darn sure we don’t do anything crazy that will cause the red to exceed the green.

With that in mind, consider the upside total return for TLT. I’ll say it’s 2.24%, which is the yield (subject to itty bitty variations in both directions that appeal to traders but not most folks). Trading zigs aside, if the return varies from 2.24%, it can only come in get worse as rising rates lead to the reverse of what we saw in Figure 1. Being longer term than IEI or SHY, TLT has to suffer more severely. It’s the same math that caused TLT to outperform on the upside.

What about IEI? The yield here is lower, 1.34%. But if rates rise, IEI will suffer to a lesser degree than TLT, again this being the flip side of what we saw before, for IEI in Table 2. The shorter term SHY is a different picture. It will fall even less in response to rising rates, but it’s here and now yield, 0.61%, is really, really low.

Let’s take SHY off the table. Let’s make this a contest between IEI and TLT.

You have a teeny-weeny upside potential with TLT turning out better than IEI if interest rates stay where they are for many years. That might happen. Or it might not. If, when and as rates rise, TLT will wind up adding downside volatility. Your probability distribution of potential outcomes from TLT in lieu of IEI looks like Figure 5 – if you squint, you’ll see a sliver of green just to the right of neutral.

Figure 5 – Probable Outcomes From Choosing TLT over IEI.

Is that what you want? Really? And by the way, it’s worse with ZROZ. It’s yield, 1.69%, is much closer to that of IEI but its volatility, vulnerability to loss if rates rise, is much more severe.

Perhaps it’s OK for my Portfolio123 friend Jack. He has an engineering background devotes substantial effort to watching the markets and following relevant news and commentary, and perhaps, might be able to squeeze out that extra percentage point or so of TLT yield and switch to IEI or even SHY is he times the trends in interest rates.

But is that you? Is this what you expect when you go into long-term fixed income or are put there by your adviser in order to mitigate the risks of equities? Yes it’s “uncorrelated.” Yes it’s “diversified.” But is it “suitable?”

Disclosure: None.